[6/13/18 Draft]

Empowering the Poor:Turning De Facto Rights into Collateralized Credit

Steven L. Schwarcz1

The shrinking middle class and the widening gap between the rich and the poor constitute significant threats to social and financial stability. One of the main impediments to upward mobility is the inability of economically disadvantaged people to use their property—in which they sometimes hold only de facto, not de jure, rights—as collateral to obtain credit. This Article argues that commercial law should recognize those de facto rights, enabling the poor to borrow to start businesses or otherwise create wealth. Recognition not only would provide benefits that exceed its costs; it also would be consistent with, if not compelled by, the jurisprudential trend to disentangle commercial and property law in order to reflect important commercial realities, rather than the arbitrary shifting of rights based on property. Recognition also would represent a radically different conception of sustainable finance, no longer dependent on charitable sources of funding, which are extremely limited, or on mandatory regulation of finance to impose social responsibility but, instead, designed to attract arm’s length funding.

1 Stanley A. Star Professor of Law & Business, Duke University School of Law; Senior Fellow, the Centre for International Governance Innovation (CIGI); and Distinguished Visiting Professor, University College London (UCL) Faculty of Laws (Spring 2018). For helpful comments, the author thanks John Armour, Giuliano Castellano, Iris H. Chiu, Alfredo Gutierrez Girault, Ben McFarlane, Christoph Paulus, Maziar Peihani, Irit Ronen-Mevorach, and participants in the Distinguished Visiting Professorship Lecture at University College London Faculty of Laws, the Doctorate College Lecture at Humboldt University of Berlin Faculty of Law, and the CLC Lecture at Harris Manchester College, University of Oxford. He also thanks Ryan Arredondo, Miata Eggerly, Jiazhen Yan, and especially Kris Liu for valuable research assistance. document.docx

2

INTRODUCTION.................................................................................................................................2I. EXPLAINING HOW AND WHY COMMERCIAL LAW OVERRIDES PROPERTY LAW.........................7II. EXPLAINING WHY COMMERCIAL LAW SHOULD OVERRIDE PROPERTY LAW TO EMPOWER THE POOR................................................................................................................................................9A. How could holders of de facto rights transfer more rights than they hold?..............................12B. Would recognition of that transfer be unfair to holders of de jure rights?................................14C. How could the de facto rights be clearly identified?................................................................19D. Would lenders be prepared to extend credit?............................................................................23E. Would the poor be willing to borrow?......................................................................................27III. EXPLAINING WHY OVERRIDING PROPERTY LAW TO EMPOWER THE POOR WOULD BE ECONOMICALLY EFFICIENT............................................................................................................28A. Estimating anticipated benefits.................................................................................................29B. Estimating anticipated costs......................................................................................................29C. Balancing costs and benefits.....................................................................................................32IV. IMPLEMENTATION....................................................................................................................32CONCLUSION..................................................................................................................................33ANNEX 1: MODEL LAW TO RECOGNIZE DE FACTO PROPERTY RIGHTS........................................35

INTRODUCTION

The shrinking middle class and the widening gap between the rich and the poor create

indirect—but nonetheless real—threats to social and financial stability.2 The World Economic

Forum has identified wealth inequality as the biggest risk to the global community.3 The noted

economist Hernando De Soto has explained how the lack of credit increases that inequality.4

2 See, e.g., How Inequality Affects Growth, ECONOMIST (June 15, 2015), https://www.economist.com/blogs/economist-explains/2015/06/economist-explains-11 (discussing “recent work suggest[ing] that inequality [in wealth] could lead to economic or financial instability”).3 WORLD ECONOMIC FORUM, GLOBAL RISKS 2014 13–14 (2014). Cf. U.N. General Assembly Resolution 70/1, at 15 (Oct. 21, 2015) (stating that the most important goal of the international community should be to “end poverty in all its forms everywhere”).4 See HERNANDO DE SOTO, THE MYSTERY OF CAPITAL: WHY CAPITALISM TRIUMPHS IN THE WEST AND FAILS EVERYWHERE ELSE 6 (2000). Although De Soto’s argument and its implications for transforming informal housing to formal title have become a cornerstone of many development programs, some empirical analyses have questioned the impact of policies based on his argument. See generally Timothy Mitchell, The Work of Economics: How a Discipline Makes its World, 46 EUROPEAN J. SOCIOLOGY/ARCHIVES EUROPÉENNES DE SOCIOLOGIE 297 (2006) (discussing the criticisms). Nonetheless, the connection between property rights and access to credit remains a central tenet of the current efforts to alleviate poverty. See, e.g., Peer Stein, Tony Goland, & Robert Stein, Two Trillion and Counting 9 (Oct. 2010) (International Finance Corporation [part of the World Bank Group] and McKinsey &

document.docx

3

De Soto argues that the poor hold their resources in defective form, living in houses built

on land that, de facto, is theirs but not legally recorded as their property.5 The World Bank

similarly estimates that, largely due to poverty, 70% of the world’s population lacks registered

title to their land.6 The poor therefore cannot use their homes as collateral to borrow and create

wealth.7 The impact is devastating not only to individuals but also to commerce because

mortgage lending is the primary source of capital used to start small businesses.8 The poor also

hold other assets that cannot currently be used as collateral due to legal constraints.9

This poses an important legal challenge: Should commercial law recognize de facto rights

—that is, rights that are recognized or respected in practice but not formally under (official) law10

—to enable the poor and other economically disadvantaged people (collectively, the

“economically disadvantaged”) to use their homes and other commonly held assets as collateral,

to obtain credit? Credit is essential to economic growth and upwards mobility:

Company joint publication) (finding that ending poverty requires bridging the so-called “credit gap”).5 DE SOTO, supra note 4, at 5–6.6 The World Bank, “Why Secure Land Rights Matter,” Mar. 24, 2017, available at http://www.worldbank.org/en/news/feature/2017/03/24/why-secure-land-rights-matter. The World Bank observes that, in many parts of the world, people simply do not know what their property rights are and, even if they try to find out, they cannot receive accurate information from government agencies. Id.7 DE SOTO, supra note 4, at 6. 8 Id.; cf. Chris Arsenault, Property Rights for World’s Poor Could Unlock Trillions in ‘Dead Capital’, REUTERS BUS. NEWS (Aug. 1, 2016), https://www.reuters.com/article/us-global-landrights-desoto/property-rights-for-worlds-poor-could-unlock-trillions-in-dead-capital-economist-idUSKCN10C1C1 (arguing that without the ability to borrow by using their homes as collateral, the poor are “unable to leverage their resources to create wealth, and their assets become ‘dead capital’ which cannot be used to generate income or growth”).9 See, e.g., Heywood Fleisig, Secured Transactions: The Power of Collateral, 33 FIN. & DEV. 44, 44 (1996). For example, legal constraints prevent movable property, such as cattle, from being used as collateral by farmers in countries like Uruguay, whereas cattle are one of the best forms of collateral in the United States. Id. at 44-45. Merchants in developing countries who would be willing to extend credit to poor farmers also may be legally constrained from taking inventory or accounts receivable as collateral. Id.10 Cf. Washington University Law Blog, Legal English: “De Facto/De Jure” (Dec. 28, 2012), available at https://onlinelaw.wustl.edu/blog/legal-english-de-factode-jure/ (observing that “de facto refers to situations that are true for practical reasons, whereas de jure refers to formal, official status of the matter”).

document.docx

4

Suppose you live in a medieval town that suffers from annual outbreaks of dysentery. You resolve to find a cure. You need funding to set up a workshop, buy medicinal herbs and exotic chemicals, pay assistants and travel to consult with famous doctors. You also need money to feed yourself and your family while you are busy with your research. . . . But how can you get the money when . . . all your time is taken up with research? Reluctantly, you go back to tilling your field, dysentery keeps tormenting the townsfolk, [and] nobody tries to develop new remedies . . . . That’s how the economy languished, and science stood still.

The cycle was eventually broken in the modern age thanks to people’s growing trust in the future, and the resulting miracle of credit. Credit is the economic manifestation of trust. Nowadays, if I want to develop a new drug but don’t have enough money, I can get a loan from a bank, or turn to private investors and venture capital funds.11

This Article argues that commercial law should recognize those de facto rights to

collateralize credit for the economically disadvantaged.12 Such collateralized credit represents a

radically different form of “sustainable finance,” which seeks to innovate finance to benefit both

the private sector and society at large.13 Almost all other forms of sustainable finance are

11 YUVAL NOAH HARARI, HOMO DEUS 236-37 (Vintage ed. 2017) (explaining the “miracle of credit”).12 Absent that recognition, the economically disadvantaged will remain unable to borrow. See, e.g., STAFF OF H.R. SELECT COMM. ON HUNGER, 100TH CONG., ACCESS AND AVAILABILITY OF CREDIT TO THE POOR IN DEVELOPING COUNTRIES AND THE UNITED STATES 1 (Comm. Print 1987) (finding that collateral requirements imposed by financial institutions prevent the poor from gaining access to credit); Michael Trebilcock & Paul-Erik Veel, Property Rights and Development: The Contingent Case for Formalization, 30 U. PA. J. INT’L L. 397, 406 (2008) (observing that collateral is not effective unless the borrower has “secure ownership of the property” that constitutes the collateral). 13 Cf. United Nations Environment Programme (UNEP), Sustainable Finance? A Critical Analysis of the Regulation, Policies, Strategies, Implementation and Reporting on Sustainability in International Finance, UNEP Inquiry Working Paper 16/03 (Feb. 2016), at 4 (discussing sustainable finance from a broader environmental, social, and governance perspective).

document.docx

5

dependent either on charitable sources of funding,14 which are extremely limited,15 or on

mandatory regulation of finance to impose social responsibility.16 In contrast, this Article’s

vision of recognizing de facto rights to collateralize credit is designed to attract arm’s length

commercial funding sources.17

The Article also explains why that recognition would be consistent with modern

principles of commercial law, why it would be economically efficient, and how that recognition

could be implemented. Commercial law increasingly recognizes important policy goals and

commercial realities as a basis to override traditional limitations imposed by property law.18

Although there are many examples,19 the leading precedent is the Uniform Commercial Code

14 Steven L. Schwarcz, Disintermediating Avarice: A Legal Framework for Commercially Sustainable Microfinance, 2011 U. ILL. L. REV. 1165, 1167 (observing that, “[h]istorically, the majority of microfinance activities had been confined to the on-lending of funds provided by charitable donors”). This Article’s vision of recognizing de facto rights to collateralize credit is also fundamentally different from the credit provided by microfinance, which does not rely on collateral: “Micro-credit does not rely on the borrower’s title to his or (more frequently) her assets as collateral or as a source of repayment to the lender. It relies on the borrower’s appreciation of the importance of the loan and corresponding willingness to repay it.” Boris Kozolchyk, Secured Lending and Its Poverty Reduction Effect, 42 TEX. INT’L L. J. 727, 731 (2007). 15 See Disintermediating Avarice, supra note 14, at 1167–68 (observing that “the need for microfinance lending vastly exceeds the amount of funds that can be raised from charitable donors. It is estimated, for example, that of the 1.5 billion people potentially eligible for microfinance loans, only 100 million people—less than 7%—receive them.”) (citation omitted).16 UNEP, supra note 13, at 4. 17 See Part II.D, infra (explaining why lenders would be prepared to extend credit).18 See Steven L. Schwarcz, Secured Transactions and Financial Stability: Regulatory Challenges, 81 LAW AND CONTEMPORARY PROBLEMS (forthcoming issue no. 1, 2018), available at http://ssrn.com/abstract=3033052 (explaining why commercial law should enable the poor to borrow based on de facto rights). 19 Many nations’ commercial law recognizes policy goals and commercial realities as a basis to override traditional limitations imposed by property law. In Germany, for example, a “bona fide acquirer may obtain the ownership of a chattel under certain circumstances although the transferor is neither the owner of the chattel nor authorized by the owner to dispose thereof.” Section 932, 892 BGB (German Civil Code, or Bürgerliches Gesetzbuch); sec. 366 HGB (German Commercial Code). See also Karsten Thorn, Germany, in TRANSFER OF OWNERSHIP IN INTERNATIONAL TRADE 211 (Alexander von Ziegler et al. eds., 2d ed. 2011). The justification is that it is often unreasonable or even impossible for the acquirer to verify the property relations before transaction. This “result is accepted in order to sustain trade and commerce” even though it “effectively leads to an expropriation of [property of] the owner.” Id. Japan’s commercial law

document.docx

6

(“UCC”), perhaps the world’s most respected codification of commercial law.20 The UCC is a

model law that is promulgated and continuously updated by the American Law Institute and the

Uniform Law Commission. The American Law Institute, with worldwide membership, is “the

leading independent organization in the United States producing scholarly work to clarify,

modernize, and otherwise improve the law.”21 The Uniform Law Commission provides “non-

partisan, well conceived, and well drafted legislation that brings clarity and stability to critical

areas of state statutory law.”22 This Article builds on the foundation provided by the UCC,

among other sources.23

For largely path-dependent reasons, including the lobbying power of the real estate Bar,

the UCC applies to security interests in personal property but not real estate.24 Nonetheless, the

UCC’s innovative principles—such as the disentanglement of commercial and property law—are

compelling and should be valid regardless of whether the property at issue is personalty or real

is similar. Tomotaka Fujita, Japan, in TRANSFER OF OWNERSHIP IN INTERNATIONAL TRADE, supra at 264 (recognizing that one who acquires the possession of movables peacefully and openly by a transactional act acquires rights in such movables if he is in good faith and without fault) (citing Minpō [Minpō] [Civ. C.] art. 192). Chile goes even further, recognizing that the “social function of ownership” makes ownership subordinate to requirements of the Nation, the national security, the public utility and health, and the preservation of the environment. Luis Felipe Lira Guzmán & Hernán A. Pitto, Chile, in TRANSFER OF OWNERSHIP IN INTERNATIONAL TRADE, supra at 90 (citing CONSTITUCIÓN POLÍTICA DE LA REPÚBLICA DE CHILE [C.P.] art. 19).20 Cf. Roy Goode, The Codification of Commercial Law, 14 MONASH U. L. REV. 135, 137 (1988) (describing the Uniform Commercial Code as the “most ambitious codification of commercial law ever attempted in any jurisdiction”).21 See https://www.ali.org/. 22 See http://www.uniformlaws.org/. 23 Cf. supra note 19 (providing examples of non-UCC commercial law that likewise recognizes policy goals and commercial realities as a basis to override property-law limitations).24 Official Comment No. 10 to UCC 9-109. Cf. Robert K. Rasmussen, The Uneasy Case Against the Uniform Commercial Code, 62 LA. L. REV. 1097, 1112–1113 (2002) (arguing that local real-estate bars preferred non-UCC lack of uniformity for rent-seeking purposes, requiring the hiring of local lawyers for real property transactions and creating an entry barrier for out-of-state lawyers seeking bar admission).

document.docx

7

estate.25 This Article’s analysis does not distinguish that nature of the collateral except as

specifically indicated.26

The Article proceeds as follows. Part I begins by explaining how and why commercial

law currently overrides property law. Part II then explains how and why commercial law should

override property law to enable the economically disadvantaged to use their de facto rights as

collateral to obtain credit. Thereafter, Part III explains why overriding property law in that way

would be economically efficient, generating benefits that exceed its costs. Part IV of the Article

examines how to implement this legal framework, comparing statutory and judicial approaches.

Finally, Annex 1 to the Article proposes the text of a model law that could form the basis of a

statutory approach (the “Model Law”).

I. EXPLAINING HOW AND WHY COMMERCIAL LAW OVERRIDES PROPERTY LAW

To underpin the normative analysis, consider how and why commercial law currently

overrides property law. This approach follows the strong scholarly precedent for grafting a

normative legal inquiry onto positive-law reality.27

25 A principal reason for differentiating transfers of interests in personalty and real property has been that, for personalty, good faith purchaser rules help to reduce transaction costs whereas real property land registration establishes a presumption of legal ownership. See, e.g., Bürgerliches Gesetzbuch [BGB] [German Civil Code], § 892 (providing a presumption of accuracy of the contents of land registry); Gebhard M. Rehm & Hinrich Julius, The New Chinese Property Rights Law: An Evaluation from a Continental Perspective, 22 COLUM. J. ASIAN L. 177, 190 (2009) (“As regards the effect of registration, Chinese law follows the German model in that registration—as for example under French law—not only destroys good faith (thus only preventing acquisition from a person not entitled to transfer the right), but is a precondition for every acquisition, including from the owner, and establishes a presumption of legal ownership in favor of the registered party.”) (citations omitted). This distinction should be irrelevant, however, to the question of recognition of de facto property rights.26 Cf. Model Law, Annex 1 hereto, Art. 1(1) (stating that such Law applies to security interests in both personal property and real property).27 See, e.g., Lucian Arye Bebchuk, A New Approach to Corporate Reorganizations, 101 HARV. L. REV. 775, 776–77 (1988) (grafting a normative analysis of bankruptcy law (what should be the best method for dividing the corporate reorganization pie) onto a positive assumption about that law (taking as given the widespread use of the corporate reorganization alternative to liquidation)). Cf. ISAIAH BERLIN, PERSONAL IMPRESSIONS xxi (Henry Hardy, ed., 2001) (arguing that norms are and should be factually based and tethered to reality).

document.docx

8

First, the UCC overrides property law in order to recognize important commercial

realities that clash with the “arbitrary shifting” of rights based on property.28 For example, UCC

9-202 provides, with very limited exceptions, that “the provisions of this Article [9] with regard

to rights and obligations apply whether title to collateral is in the secured party or the debtor.”

This enables commercial law to recognize the reality that the “retention or reservation of title by

a seller of goods notwithstanding shipment or delivery to the buyer . . . is limited in effect to a

reservation of a ‘security interest.’”29 That recognition “provides a clearer and more coherent

system for dealing with . . . conflicts” over competing rights.30

Similarly, UCC 2-401 provides (again, with very limited exceptions) that each “provision

of this Article [2] with regard to the rights, obligations, and remedies of the seller, the buyer,

purchasers or other third parties applies irrespective of title to the goods . . . .” This enables

commercial law to recognize the reality that the risk of losing goods in shipment should be

allocated to the party who “control[s] the goods and can be expected to insure his interest in

them,”31 whether or not that party owns the goods at the time of their loss.32 Commercial law

recognition of that reality is widely touted as providing “enormous” gains “in clarity,

28 Cf. Official Comment No. 1 to UCC 2-509 (observing that the “underlying theory” is to avoid “an arbitrary shifting of the risk with the ‘property’ in the goods”). The UCC itself does not yet clearly embrace the recognition of de facto rights as a basis to grant a security interest. Cf. UCC 9-203(b)(2) & Official Comment No. 6 thereto (requiring the debtor to have “rights in the collateral” as a condition of granting a security interest therein, but not discussing whether de facto rights might suffice). But cf. Michael Bridge & Jo Braithwaite, Private Law and Financial Crises, 13 J. CORP. L. STUDIES 361 (Oct. 2013) (discussing how conflating contract and property in derivatives transactions in insolvency can jeopardize financial stability).29 UCC 1-201(b)(35) (defining a “security interest”).30 Sean Thomas, “The Role of Authorisation in Title Conflicts Involving Retention of TitleClauses: Some American Lessons,” 1 (unpublished manuscript, available at http://dro.dur.ac.uk/18323/1/18323.pdf).31 Official Comment No. 3 to UCC 2-509.32 UCC 2-509.

document.docx

9

translatability and practicability.”33 It has also become the basis for allocating risk of loss under

the United Nations Convention on Contracts for the International Sale of Goods (CISG).34

The UCC also overrides property law to recognize important policy goals. For example,

to facilitate the transferability of goods, it gives good faith purchasers greater rights in the

transferred goods than the seller itself had.35 This recognizes that it would be prohibitively

expensive to buy goods (such as a computer) from a store if, to protect your purchase, you had to

perform due diligence on whether the store actually owned the computer and whether the

computer might be encumbered by any third party rights. For these same reasons, the UCC

similarly facilitates the transferability of negotiable instruments that substitute for money.36

II. EXPLAINING WHY COMMERCIAL LAW SHOULD OVERRIDE PROPERTY LAW TO EMPOWER THE POOR

Commercial law thus recognizes important policy goals and commercial realities as a

basis to override traditional limitations imposed by property law. By that measure, commercial

law should also override those limitations to enable the economically disadvantaged to pledge de

facto rights in their homes and other assets as collateral to obtain credit. The ability to pledge

those rights would achieve an important policy goal: unlocking “the entrepreneurial potential of

billions of people.”37 It also would facilitate an important commercial reality: allowing de facto

33 John Honnold, The New Uniform Law for International Sales and the UCC: A Comparison, 18 INT’L LAW. 21, 27 (1984). Recognition of reality strongly influences the UCC. Cf. Henry E. Smith, On the Economy of Concepts in Property, 160 U. PENN. L. REV. 2197, 2124 (2012) (observing that in “drafting the Uniform Commercial Code, Llewellyn set out to diminish the importance of title, a decision fully justified according to the Realist-inspired conventional wisdom”). 34 See Honnold, supra note 33, at 27 (discussing the CISG’s rules in articles 66-70 for allocating risk of loss, and observing that those “rules on risk of loss are closely patterned on the modern rules of the UCC. The approach is the same: the elusive concept of property . . . is not employed. Instead, the Convention’s rules are drafted in terms of concrete commercial events—handing over goods to the carrier and the buyer’s ‘taking over’ physical possession from the seller.”). 35 See infra notes 51-53 and accompanying text (discussing holders in due course of instruments and buyers in ordinary course of goods).36 See id.37 Arsenault, supra note 8.

document.docx

10

right-holders gainfully to use property that de jure owners are not using (and do not intend to

use38).

There is, however, another justification for enabling the economically disadvantaged to

pledge de facto rights in their homes and other assets as collateral 39: de facto rights are real

rights, though not formally recognized.40 Property law nonetheless implicitly recognizes de facto

rights through its view of property as a “bundle of entitlements regulating relations among

persons concerning a valued resource.”41 This bundle-of-entitlements—sometimes called a

bundle-of-sticks—conception of property law reveals that a property right can be more complex

than simple “ownership” of property.

For example, rights in property may include the right to use, the right to exclude use, and

the right to transfer,42 and different persons can have different rights in the same property.43 The

economically disadvantaged often have the right to use the property where they live and,

arguably, also to exclude use of that property by others.44 These rights are de facto because they

38 I restrict this Article’s application to property as to which the de jure owners fail to provide clear notice to preserve their rights. See infra note 75 and accompanying text. See also Model Law Art. 4(3). 39 Yet another justification for overriding property law is that the law should correct market failures. See, e.g., PAUL A. SAMUELSON & WILLIAM D. NORDHAUS, ECONOMICS 756 (15th ed. 1995). Property law itself arguably creates a market failure by enabling the de jure owner to abandon using the property commercially while preventing the de facto right-holder from using it. 40 Professor Paulus observes that, in Medieval times, jurists already recognized a distinction between de jure rights, called dominium directum, and de facto rights, called dominium utile. E-mail from Christoph Paulus, Professor of Law, Humboldt University of Berlin, to the author (Apr. 20, 2018).41 Anna di Robilant, Property: A Bundle of Sticks or a Tree?, 66 VAND. L. REV. 869, 871 (2013). 42 JOSEPH WILLIAM SINGER, ET AL., PROPERTY LAW: RULES, POLICIES AND PRACTICES xxxiv (7th ed. 2017). 43 Id. at 665. For example, person A may have title to Blackacre. Through an easement, person B may gain the right to use person A’s land, while not having the right to exclude A or even a stranger, person C. To that extent, person B has a “real” property right. See id. at 534 (describing a nonexclusive easement in which a grantor has reserved the right to use the easement in conjunction with the grantee, as well as the ability to sell further rights to others).44 See, e.g., KLAUS W. DENINGER, THE WORLD BANK, LAND POLICIES FOR GROWTH AND POVERTY REDUCTION 52 (2003) (citing Botswana as a country where individuals have the right to exclude others from land, even though formal title is held by the state or community); Bui Quoc Toan, et al., Vietnam: Customary Land Tenure Study 9 (The World Bank, EASRD

document.docx

11

are respected in practice but not formally under (official) law.45 The economically disadvantaged

also have the de facto right to transfer their use-and-exclusion rights, at least to family members

such as children.46

In order to turn these de facto rights into collateralized credit, the economically

disadvantaged would also need to be able to transfer security interests in that property to lenders,

as collateral for loans. Given their de facto right to transfer their use-and-exclusion rights to

related parties,47 enabling the economically disadvantaged to transfer security interests in those

rights to obtain credit should be a trivial additional step—certainly justified by its benefits.48

However, lenders almost certainly would require another step that is far from trivial:

transferring a security interest in the underlying de jure rights in the property. This reflects the

practical reality that they are unlikely to extend credit unless, in a foreclosure, they can obtain the

full rights—both de facto and de jure—in the property pledged as collateral.49

This poses a puzzle: a borrower that has only de facto rights in that property cannot

normally pledge greater rights. This reflects the long-standing property law principle of “nemo

dat”50—the concept that one cannot transfer more rights than one owns. How could holders of de

facto rights also transfer the de jure rights?

Working Paper Series, Working Paper No. 37417, 2004), available at http://documents.worldbank.org/curated/en/855721468174546190/Vietnam-customary-land-tenure-study (observing that de facto land owners in Vietnam have a restricted right to exclude others).45 Cf. supra note 10 and accompanying text (defining de facto rights).46 DENINGER, supra note 44, at 31 (noting that most customary systems have inheritable rights to cropland); Cong Bao Nos 1011-1012 [Land Law], No. 45/2013/QH13 (Dec. 31, 2013) (describing the ability to transfer and inherit land-use rights in Vietnam); LANEY ZHANG, CHINA: REAL PROPERTY LAW 4 (2015) (describing the ability to transfer land-use rights in China).47 See supra note 46 and accompanying text.48 See supra notes 37-38 and accompanying text (discussing these benefits).49 Absent foreclosure, ownership of the underlying de jure rights in the property would be unaffected because the security interest terminates once the loan is repaid. [cite] Even in a foreclosure, the owner of those underlying de jure rights would retain any surplus value in the property not needed to repay the lender. Cf. UCC § 9-615(d)(1) (providing for the return of such surplus value to the property owner). 50 The phrase, more precisely, is nemo dat quod non habet. There is also a parallel phrase, nemo plus iuris transfere potest quam ipse habet (No one can transfer more rights than he himself has.).

document.docx

12

The Article next attempts to solve that puzzle, examining when commercial law should

modify property law’s nemo dat restriction. Thereafter, the Article addresses other questions that

would be raised by turning de facto rights into collateralized credit, including whether

recognizing de facto rights would be unfair to holders of de jure rights, whether the de facto

rights could be clearly identified, and—assuming satisfactory answers to the foregoing questions

—whether lenders would be prepared to extend, and the economically disadvantaged would be

prepared to accept, credit.

A. How could holders of de facto rights transfer more rights than they hold?

Commercial law already addresses this conundrum. To facilitate the transferability of

negotiable instruments (such as promissory notes), commercial law gives so-called holders in

due course full unencumbered rights to these transferred instruments.51 Similarly, to facilitate the

sale of goods, commercial law gives buyers of goods, in the ordinary course of business,52 full

unencumbered rights to those goods.53 If commercial law did not override property law in these

ways, the transaction costs of negotiating instruments and selling goods would become

prohibitive. As mentioned, it would be prohibitively expensive to buy a computer from a store if

the buyer had to perform due diligence to ensure the seller’s ownership and the absence of third-

party encumbrances.54

These “bona fide purchaser” exceptions from nemo dat epitomize commercial law’s

recognition of important policy goals and commercial realities as a basis to override property 51 See UCC 3-305 (providing that the right of a holder in due course to enforce the obligation of a party to pay an instrument is not subject to defenses of the obligor stated in subsection (a)(2) or claims in recoupment stated in subsection (a)(3) against a person other than the holder). 52 A buyer of goods in the ordinary course of business is conceptually similar to a holder in due course of negotiable instruments. Both effectively include a person who purchases goods, or receives the transfer of such an instrument, for value, in good faith, and without knowledge that the purchase or transfer violates the rights of another person. Compare UCC 1-201(9) (defining buyer in ordinary course) with UCC 3-302(a) (defining holder in due course).53 See, e.g., UCC 9-320 (providing that a buyer of goods in ordinary course of business takes free of a security interest created by seller of the goods, even if the buyer knows of the security interest’s existence); UCC 2-403(2) (providing that the entrusting of possession of goods to a merchant who deals in goods of that kind gives the merchant power to transfer all rights of the entruster to a buyer in ordinary course of business). 54 See text accompanying notes 35-36, supra.

document.docx

13

law’s limitations. But should access to collateralized credit justify another exception to nemo dat,

enabling the economically disadvantaged to pledge not only their de facto rights but also the

underlying de jure rights? In answering this question, one should realize that although nemo dat

is a “common sense” rule,55 one of the world’s leading property-law scholars observes that “one

could imagine all sorts of different rules, based on the relative qualities of [competing parties], to

determine who had the better title—their virtue, their need, and so on.”56 Moreover, in practice

(and without any overarching theory57), “exceptions to nemo dat apply often, if not most of the

time.”58

Taking into account common sense and practicality, this Article proposes the following

answer: the critical benefits provided by access to collateralized credit59 should justify another

exception to nemo dat—to enable the economically disadvantaged to transfer as collateral the

underlying de jure rights as well as their de facto rights—if doing so is not unfair to holders of

those underlying rights. The Article next examines whether recognition of that transfer would be

unfair to holders of those underlying rights.

B. Would recognition of that transfer be unfair to holders of de jure rights?

Commercial law constantly grapples with conflicting rights and the need for fairness.

Questions of balancing rights and fairness arise when giving holders in due course

unencumbered rights to transferred negotiable instruments, and also when giving buyers of

55 Smith, supra note 33, at 2120.56 Id. at 2120–21. Smith is the Fessenden Professor of Law at Harvard Law School.57 Id. at 2122 (concluding that it is “easier to describe . . . a set of exceptions to nemo dat than [a] freestanding rule[]” for those exceptions).58 Id. at 2121. Professor Kochan similarly describes exceptions to nemo dat as a practical compromise: “Whereas strict adherence to nemo dat might be theorized as the ‘first-best’ solution to fraudulent and recurrent land conveyances and best at adhering to our formalistic tendencies, the realities of property make that solution less than satisfactory and make exceptions justifiable. We have accepted pragmatically that exceptions must be made and that we may have to, in essence, validate fraud at times.” Donald J. Kochan, Dealing with Dirty Deeds: Matching Nemo dat Preferences with Property Law Pragmatism, 64 KANSAS L. REV. 1, 3 (2105).59 These benefits include unlocking the entrepreneurial potential of billions of people (see supra note 37 and accompanying text), recognizing the important commercial reality that the de jure owner is not using the property whereas the economically disadvantaged may be motivated to use it (see supra notes 37-41 and accompanying text), and more generally reducing poverty and facilitating upwards mobility.

document.docx

14

goods in the ordinary course of business unencumbered rights to those goods.60 The answers to

these questions inform how rights and fairness should be balanced in the context of this Article’s

proposal to recognize de facto rights.

Recall that a holder in due course can receive the transfer of an encumbered instrument—

even one that is already subject to third-party rights, such as a lien—effectively free and clear of

the encumbrance.61 The implicit fairness rationale is that the party with the original encumbrance

could have preserved its rights by providing clear notice of those rights to subsequent

transferees.62 Similarly, a buyer of goods in the ordinary course of business can purchase the

goods free and clear of an existing encumbrance and can even purchase full title to goods from a

seller with only limited title.63 Again, the implicit fairness rationale is that the party with the

original encumbrance or title could have preserved its rights by providing clear notice of those

rights to subsequent transferees.64

Providing clear notice to preserve original rights also has precedent in the somewhat

parallel tension between the de jure rights of landowners and the de facto rights of squatters. In

many jurisdictions, squatters can ultimately obtain superior rights over the land they occupy

under the law of adverse possession.65 Having its roots in the English common law rule of 60 See supra notes 51-53 and accompanying text.61 See UCC 9-330(d) (providing that such a transferee of an instrument “has priority over a security interest in the instrument perfected by a method other than possession”). 62 See Official Comment No. 7 to UCC 9–330. An additional fairness rationale is that the party with the original encumbrance may also have a claim for losses against the transferor. [cite] As a rough parallel, this Article suggests giving holders of underlying de jure rights a profit-sharing upside in the business started by the borrower. See infra note 74. 63 See supra note 53.64 The Official Comments to UCC 9-320 clarify, for example, that a buyer purchases goods subject to a security interest if the buyer is informed that its purchase is intended to be so encumbered. And if a buyer purchasing goods entrusted to a merchant is informed that the merchant’s right to sell the goods is limited, the buyer would not be a “buyer in the ordinary course” for purposes of UCC 2-403. An additional fairness rationale is that the party with the original encumbrance or title encumbrance may also have a claim for losses against the seller of the goods. [cite] Again, as a rough parallel, this Article suggests giving holders of underlying de jure rights a profit-sharing upside. Compare note 62, supra, with note 74, infra.65 See generally EDUARDO MOISES PENALVER & SONIA K. KATYAL, PROPERTY OUTLAWS: HOW SQUATTERS, PIRATES, AND PROTESTORS IMPROVE THE LAW OF OWNERSHIP 60–61 (2010) (explaining how adverse possession, among other laws, has been used to give squatters formal property rights over absentee owners). See also SINGER, ET AL., supra note 42, at 104 (observing

document.docx

15

disseisin, adverse possession enables a trespasser to acquire imperfect possessory rights that

could, over time, become perfect legal title if the trespasser’s use of the land is “open and

notorious”66 and the owner does not act to prevent the trespasser.67

The requirements that the trespasser’s use of the land be open and notorious and that the

owner does not act to prevent the trespasser are grounded in reality. The open-and-notorious

requirement takes into account not only whether the trespasser’s use is effectively permanent

(such as living long-term in a home, as opposed to occasionally picking berries) but also whether

such use effectively provides reasonable notice to the owner, enabling the owner to object before

losing its land.68 Courts also consider who the community believes owns the land.69 The owner-

does-not-act requirement enables an owner to preserve its rights by providing explicit

notifications, such as posting no-trespassing signs, locking doors, and blocking entry to the

land.70

Adverse possession recognizes that a person who has used certain land for a long time

may have settled expectations, and that the de jure landowner may have forgotten about or

essentially abandoned the land.71 Protecting de jure rights might then give the landowner a

windfall and inflict a huge loss on the land-user. Adverse possession thus can promote the

that the government often granted formal property rights in the United States to individuals squatting on public land). But cf. id. at 309 (discussing recently passed state statutes restricting adverse possession). 66 SINGER, ET AL., supra note 42, at 310–15. In the United States, adverse possession law is state law, not federal law. The majority of U.S. states require a trespasser to prove with clear and convincing evidence (1) “actual possession” for a (2) statutory period (different for each state), that is (3) open and notorious, (4) adverse and hostile, (5) continuous, and (6) exclusive. Id. at 293.67 See, e.g., Lee J. Alston, et al, “De Facto and De Jure Property Rights: Land Settlement and Land Conflict on the Australian, Brazilian and U.S. Frontiers,” NBER Working Paper #15264, Sep. 2009, at 19, available at http://www.nber.org/papers/w15264 (discussing, among other things, how adverse possession has allowed squatters to transform their occupation into legal title). 68 SINGER, ET AL., supra note 42, at 294.69 Id. at 310-15.70 Id.71 Id.

document.docx

16

effective utilization of land and also can reduce transaction costs by preventing litigation over

“stale” claims to land, such as a claim by a supposed owner from decades ago.72

Applying this same type of approach to collateralized credit—recognizing the original de

jure rights of persons who provide clear notice to preserve those rights—should similarly respect

fairness73 while helping to promote the effective utilization of property.74 To avoid doubt,

however, any such notice should be physically obvious and manifestly clear. It might include, for

example, posting no-trespassing signs, locking doors, and/or blocking entry or access to

property.75 It should not include notices posted by mail or distributed electronically or through

72 See id. at 293.73 Cf. Kochan, supra note 58, at 52-60 (advocating an “inquiry notice” approach to give original owners “additional opportunities to protect their title interests”). A legal process that respects fairness while promoting the effective utilization of property should also be respected under laws that protect private property, such as Protocol 1, Art 1, of the European Convention on Human Rights (“Protection of property”):

(1) Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law. (2) The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest . . . .

74 To additionally respect fairness, holders of the de jure rights could receive a profit-sharing upside—such as the right to receive a specified percentage of profits, for a specified period, from the business started by the de facto owner. That would help to balance the risk that de jure right-holders could lose their rights in a foreclosure. A profit-sharing upside would also be consistent with the concept of corrective justice, which requires a person to repair losses that his conduct causes even if the person is not morally to blame for the losses. Stanford Encyclopedia of Philosophy, Theories of the Common Law of Torts § 3.1, available at https://plato.stanford.edu/entries/tort-theories/#CorJus (visited June 12, 2018). Cf. Christopher H. Schroeder, Corrective Justice and Liability for Increasing Risks, 37 UCLA L. REV. 439, 439 (1990) (arguing that ideal corrective justice should not be subject to a causation requirement; a person who increases the risk of harm occurring should be liable, period). 75 Cf. Model Law Art. 4(3) (enabling de jure right-holders to provide clear notice to preserve their rights). Compare Model Law Art. 3(2) (defining “clear notice”) with supra note 70 and accompanying text (discussing clear notice in the context of adverse possession law).

document.docx

17

the media.76 Furthermore, no such notice should impair the right of economically disadvantaged

persons to continue living on or using property.77

One nonetheless might question whether allowing de jure right-holders to give notice

could effectively prevent the disadvantaged from obtaining credit: Wouldn’t reasonable de jure

right-holders always give notice, thereby preventing foreclosure on their property (and thus

effectively preventing it from being used as collateral)? In answer, relatively few de jure right-

holders likely know of their rights; it is unclear who, other than the government,78 owns much of

the property in which the disadvantaged hold de facto rights.79

That itself raises the question of whether it is fair to impair property rights of persons

who are unaware they hold such rights. At least in partial answer, the law has a long tradition of

cutting off such rights, epitomized not only by adverse possession law80 but also by escheatment

law which treats property as abandoned if the owner is unknown or cannot be located.81 76 The clear-notice requirement raises a practical problem that could be caused by physical deterioration of the notice or even by economically disadvantaged persons intentionally removing signs, unlocking doors, or otherwise unblocking entry or access to property prior to granting a security interest. To attempt to balance interests, Article 4(3) of the Model Law provides, in part, that the grant of a security interest in de facto rights shall not include a security interest in the underlying de jure rights if, at any time within the 90-day period prior to the grant of a security interest in such de facto rights, there exists clear notice of the intent of the owner of the underlying de jure rights to preserve such de jure rights. Thus, if a no-trespassing sign blows away or is removed 30 days prior to the grant of a security interest in such de facto rights, the owner of the underlying de jure rights remains protected. But if a no-trespassing sign blows away or is removed 91 days prior to the grant of a security interest in such de facto rights, the security interest also attaches to the underlying de jure rights. The owner of the underlying de jure rights could protect those rights by monitoring the property at least every 90 days. 77 Cf. Model Law Art. 4(4) (providing that notices shall not otherwise impair de facto rights).78 See infra note 82 and accompanying text.79 Cf. supra note 6 (referencing a World Bank study discussing the uncertainties associated with property rights); Martin E. Gold & Russell B. Zuckerman, Indonesia Land Rights and Development, 28 COLUM. J. ASIAN. L. 41, 53–56 (2015) (finding that the majority of land in Indonesia is not formally registered); Country Profiles: Honduras, USAID, https://land-links.org/country-profile/honduras/#land (last updated Apr. 2011) (“Approximately 80% of the privately held land in the country is untitled or improperly titled. Only 14% of Hondurans legally occupy properties and, of the properties held legally, only 30% are registered.”). 80 See supra notes 71-72 and accompanying text (discussing adverse possession law, which recognizes that the de jure landowner may have forgotten about or essentially abandoned the land and also seeks to prevent litigation over stale claims).81 See, e.g., 30A C.J.S. Escheat § 12 (2007).

document.docx

18

Furthermore, the government itself appears to own a significant portion of the property in which

the disadvantaged hold de facto rights.82 To that extent, the question of fairness would be less

critical, devolving instead into a political issue. This Article suggests that the government should

subordinate its de jure rights to the rights of the politically disadvantaged.83

One also might ask whether an alternative to this Article’s proposal should be to extend

adverse possession law more widely.84 Adverse possession law, however, is much more onerous

because it deprives de jure right-holders of title outright, not merely in the event of a lender

foreclosure.85 Moreover, unlike adverse possession, this Article’s proposal encourages, and

indeed is conditioned on, the economically disadvantaged borrowing to start small businesses.86

C. How could the de facto rights be clearly identified?

This question is perhaps the most difficult, in practice. To satisfy lenders and create

credit, commercial law must clearly define and identify de facto rights in collateral. However, 82 See, e.g., Liz Alden Wily, “Customary Land Tenure in the Modern World, Rights to Resources in Crisis: Reviewing the Fate of Customary Tenure in Africa” - Brief #1 of 5 (Nov. 2011), available at https://dlc.dlib.indiana.edu/dlc/bitstream/handle/10535/7713/customary%20land%20tenure%20in%20the%20modern%20world.pdf?sequence=1&isAllowed=y. Wily finds that the landholding status of forests, rangelands, marshlands, and other uncultivated lands in Africa is often regarded by the government “as un-owned public lands or state property.” Id. at 1. She also finds that this type of landholding status represents a “major tenure system on a worldwide scale” and “is not confined to Africa.” Id. at 2. Cf. ALAIN DURAND-LASSERVE & LAUREN ROYSTON, HOLDING THEIR GROUND: SECURE LAND TENURE FOR THE URBAN POOR IN DEVELOPING COUNTRIES 67 (2002) (noting that “in a large number of sub-Saharan African countries . . . the land is owned and managed by the state”); Robin Mearns, Access to Land in Rural India, Policy Issues and Options 28 (World Bank Policy Research, Working Paper No. 2123, 1999) (“In rural India, some of the most important village commons include community forests, pasture or ‘wasteland’, river banks, river beds, ponds and tanks. Forest department land may also form de facto commons, whether or not local inhabitants have legal rights to its products. In total, commons may account for around 20 percent of India’s total land area.”).83 Cf. Model Law Arts. 4(2) & 4(3) (providing that government-owned property is subject to foreclosure).84 Several commentators have asked this question.85 See supra note 49 (observing that, absent foreclosure, ownership of the underlying de jure rights in the property would be unaffected because the security interest terminates once the loan is repaid; and that even in a foreclosure, the owner of those underlying de jure rights would retain any surplus value in the property not needed to repay the lender). 86 There are other differences, possibly less significant. For example, adverse possession law applies only to real estate. [cite] Also, this Article’s proposal, unlike adverse possession, contemplates the possibility of profit sharing. See supra note 74.

document.docx

19

existing real estate recording systems identify only de jure rights, and they tend to use metes and

bounds or other parameters for identification that might not always be practical to describe de

facto rights.87

De Soto addressed this question by arguing that economically disadvantaged people have

developed their own ways of determining who owns what, as part of “extralegal social

contracts,” and that any reform should be based on—or at least rooted in—these behavioral

norms and customs.88 When traveling through Indonesian rice paddies, he observed to

government officials that there was no clear way of knowing where one farmer’s land ended and

another’s began, but “the dogs knew.”89 Every time he “crossed from one farm to another, a

different dog barked. Those Indonesian dogs may have been ignorant of formal law, but they

were positive about which assets their masters controlled. By traveling their city streets . . .

listening to the barking dogs, they could gradually work upward . . . until they made contact with

the ruling social contract.”90

One of the Indonesian officials characterized this as “Jukum Adat,” the people’s law.91 A

people’s law approach actually has strong commercial law precedent. For example, UCC 1-303

recognizes course of performance92 and course of dealing.93 A “course of performance or course 87 See e.g., SINGER, ET AL., supra note 42, at 950–51 (describing three methods used to identify real property boundaries in deeds: metes and bounds, government surveys, and plats); DAVID C. LING & WAYNE R. ARCHER, REAL ESTATE PRINCIPLES: A VALUE APPROACH 59–65 (4th ed. 2013) (describing three legal methods used to measure property boundaries: metes and bounds, subdivision plat and block number, and government rectangular survey). Metes measures land by indicating the distance (and sometimes the compass bearing) between specified points. Bounds measures land by its position relative to known landmarks, such as streams, walls, or roads. WALTER G. ROBILLARD & DONALD A. WILSON, BROWN’S BOUNDARY CONTROL AND LEGAL PRINCIPLES 86–94 (7th ed. 2013). 88 DE SOTO, supra note 4, at 172–75.89 Id. at 163.90 Id.91 Id.92 A “course of performance” is a “sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection.” UCC 1-303(a).93 A “course of dealing” is a “sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of

document.docx

20

of dealing between the parties . . . is relevant in ascertaining the meaning of the parties’

agreement, may give particular meaning to specific terms of the agreement, and may supplement

or qualify the terms of the agreement.”94

The practical problem, though, is that a people’s-law or similar approach might not

sufficiently identify the collateral to satisfy lenders. The challenge is to adequately identify the

collateral without generating prohibitively high transaction costs. Technology affords at least one

way to accomplish that. Either the government, an NGO, or in some cases perhaps a local

neighborhood association could organize the residents to allocate their de facto property rights

by setting flags or other visible markers at the boundaries.95 Satellite, drone, or other overhead

imagery could then document that, for translation into an accurate and easily ascertainable

description of those allocated boundaries.96 The law would respect that allocation if it followed a

prescribed methodology,97 which—for the reasons discussed below98—need not conform to the

jurisdiction’s existing mortgage-recording system.99 The allocation would be transcribed to a

government record that lenders could search.100

understanding for interpreting their expressions and other conduct.” UCC 1-303(b).94 UCC 1-303(d).95 Cf. Trebilcock & Veel, supra note 12, at 457–458 (noting that the Republic of Cameroon’s title process involved state agents placing concrete boundary markers on farmers’ land).96 This might be done, for example, using GPS. Cf. Victor Neene & Monde Kabema, Development of a Mobile GIS Property Mapping Application using Mobile Cloud Computing, INT’L J. OF ADVANCED COMPUTER SCI. & APPLICATIONS 57, 57–66 (Oct. 2017) (providing examples of using current technologies to map properties and explaining how to develop and use a mobile property mapping application). The costs associated with doing this could be borne by governments or NGOs or collectively by local communities. Although it is a political issue, some developed nations that maintain satellites might be willing to absorb the cost of satellites imagery. 97 Cf. Model Law Arts. 5(2) & 5(3) (discussing reasonable methods for describing collateral).98 See infra notes 102-111 and accompanying text.99 Any disagreement about a boundary between de facto rights could be resolved at the local level. Cf. Gold & Zuckerman, supra note 79, at 61 (observing that the majority of land disputes in Indonesia are resolved locally by the village head, who applies custom as modified by Sharia law); Mastewal Yami & Katherine A. Snyder, After All, Land Belongs to the State: Examining the Benefits of Land Registration for Smallholders in Ethiopia, 27 LAND DEGRADATION & DEV. 465, 473–474 (2016) (observing that complaint handling committees, village elders, and religious leaders work together in Ethiopia to resolve disputes over land boundaries that cannot be resolved by land administration officials). 100 Cf. Model Law Art. 5(4) (respecting allocations that follow prescribed methodologies).

document.docx

21

The commercial law distinction between the clarity needed to create a security interest

and the clarity needed to perfect that interest helps to explain why this approach would provide

sufficient clarity at low transaction costs. Creating a security interest requires a reasonably

identifiable description of the collateral because it effects the transfer of that interest from a

debtor to a secured creditor.101 This Article’s approach reasonably identifies the collateral in two

steps: first, recognizing the de facto rights collectively; second, recognizing an allocation of

those rights that follows the relevant prescribed methodology.102

That methodology need not conform to the jurisdiction’s existing mortgage-recording

system. The primary purpose of a mortgage-recording system is to give notice to third parties,

not necessarily to allocate rights between a debtor (mortgagor) and secured creditor

(mortgagee).103 Whether the collateral is real estate or personal property, the debtor and secured

creditor need only clearly identify the collateral as between themselves.104

Much less clarity is needed, in contrast, to perfect a security interest—a step often

required under law to put third parties on notice that property may be encumbered as collateral.105

For real estate, perfection normally involves describing the collateral in a mortgage-recording

system.106 Although mortgage-recording descriptions often specifically identify the collateral by

official government surveys or metes and bounds,107 the description need not be that specific.

101 Cf. UCC 9-108(a) (providing that “a description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described”). This description is normally included in the security agreement that creates the security interest. Cf. UCC 9-201(a) (providing that a security agreement is “effective according to its terms between the parties”).102 See supra notes 97-98 and accompanying text.103 Cf. SINGER, ET AL., supra note 42, at 995–96 (explaining that lenders use mortgage-recording systems “to understand and give notice to others of their security interest in the property”).104 Dale A. Whitman, What You Didn’t Know about Real Estate Recording Acts, 11 SEC. REAL PROP., TR. & EST. L. 1 (2016).105 The rationale for perfection is that notice avoids misleading third parties. What Does it Mean to Perfect a Lien?, NOLO PRESS, https://www.nolo.com/legal-encyclopedia/what-does-mean-perfect-lien.html (last visited Jun. 5, 2018) (stating that the recording required to perfect a mortgage serves to give other parties notice of the lien). An encumbrance on property that is not disclosed is often condemned as a “secret lien.” Michael Simkovic, Secret Liens and the Financial Crisis of 2008, 83 AM. BANKR. L.J. 253, 256 (2009).106 See Lori Anne Czepiel et al., Lending and Taking Security in the United States: Overview, Practical Law, Country Q&A 9-501-2871 (Thomson Reuters database, updated March 2018).107 See supra note 87 and accompanying text.

document.docx

22

Because the agreement creating the security interest provides the specificity,108 perfection only

requires notice to third parties that property might be subject to a security interest.109 A

description of collateral is sufficient for perfection if it merely “provides notice that a person

may have a security interest in the collateral claimed.”110 This minimal description requirement

reduces transaction costs.111

In principle, this approach should enable a lender to perfect its security interest in

allocated de facto rights by filing in the applicable mortgage-recording system a standard

description of the broader de jure rights. That description might even be a copy of the existing

recorded description of those rights.112 It would not need to actually re-describe those allocated

rights using metes and bounds or other mortgage-recording parameters.113

D. Would lenders be prepared to extend credit?

Assuming satisfactory answers to the foregoing questions, would banks and other lenders

actually extend credit to economically disadvantaged borrowers, based primarily on collateral?

Being a practical question, this can only be answered empirically based on what lenders actually

do.114 Nonetheless, the following observations may inform the answer.

108 See supra notes 101-104 and accompanying text.109 [cite1 to mortgage source of authority]110 Official Comment No. 2 to UCC 9-504. For that reason, a financing statement is sufficient to describe the collateral if it simply provides an indication that it covers “all assets or all personal property.” UCC 9-504(2). Compare UCC 9-308(a) (providing that a security interest is perfected if it has attached and all of the applicable requirements for perfection in Sections 9-310 through 9-316 have been satisfied) with UCC 9-310(a) (stating the general rule that “a financing statement must be filed to perfect all security interests”).111 Cf. UCC 9-308(c) (providing that “[i]f a secured party assigns a perfected security interest . . . , a filing under this article is not required to continue the perfected status of the security interest against creditors of and transferees from the original debtor.”). The logic is that the original notice filing should be sufficient to inform third parties that the collateral may be encumbered. Cf. Peter F. Coogan, Public Notice under the Uniform Commercial Code and Other Recent Chattel Security Laws, Including “Notice Filing,” 47 IOWA L. REV. 289, [cite] (1962) (“If the easier methods of [notice] filing are intelligently used, the [Uniform Commercial] Code will make a great contribution toward simplifying security transactions.”).112 Cf. Model Law Art. 7(2) (allowing that description).113 [Consider providing a concrete example-cite1] [Also compare how adverse possession law identifies de facto rights and how that might inform the above discussion. cite1]114 [Consider whether to interview representative bankers. cite1. If we do this, we may need IRB permission.]

document.docx

23

Bank lending traditionally has focused on “two-ways out,” such as asset value and cash

flow as dual means of repaying the loan.115 With the resurgence of leveraged buyouts (“LBO”s)

and other leveraged acquisition-of-control financing, banks sometimes have shifted their focus to

concentrate more on asset value as the repayment source.116 Banks finance these transactions by

looking primarily to the assets of the target (i.e., acquired) company as collateral.117 The key is

that the loans be sufficiently overcollateralized—that their collateral value exceed the amount of

the loan by a reasonable margin, enabling repayment in the event of a default.118

This Article’s concept of extending credit to economically disadvantaged borrowers

would follow that pattern: the lenders would look primarily to the collateral. Although their

potential second way out would be the profits of small businesses started with the proceeds of

115 Cf. Mark Carey et al., Does Corporate Lending by Banks and Finance Companies Differ? Evidence on Specialization in Private Debt Contracting, 53 J. FIN. 845, 850–51 & n.2 (1998) (observing that banks can be asset-based lenders and cash-flow-based lenders); Lynn M. Lopucki, The Unsecured Creditor’s Bargain, 80 VA. L. REV. 1887, 1924–47 (1994) (dividing unsecured lending into asset-based unsecured lending and cash-flow-based unsecured lending).116 [cite]117 Indeed, lending for breakup or bust-up LBOs depended almost entirely on the target company’s sales of its assets for repayment. See Appendix H—Glossary, FED. BANK. L. REP. (C.C.H.), 2015 WL 6277290 (observing that for loans made to finance “takeovers, leveraged buyouts, and restructurings,” “interest and principal payments in the future is limited; repayment often depends on asset sales rather than the ongoing profitability of the business”).118 Steven L. Schwarcz, Regulating Complacency: Human Limitations and Legal Efficacy, 93 NOTRE DAME L. REV. 1073, 1093 (2018) (observing that “loans that are not initially overcollateralized are inherently risky, given that a decline (or even a plateau) in collateral value could jeopardize repayment”). In the context of pledging de facto rights as collateral, this would mean that the value of that collateral should exceed the amount of the loan by some reasonable margin.

document.docx

24

their loans,119 small business start-ups have a high failure rate.120 Prudent lenders therefore would

insist, as indicated above,121 that their loans be sufficiently overcollateralized.122

Abuses leading up to the global financial crisis of 2007-08 have created uncertainty,

however, for asset-based lending to economically disadvantaged borrowers. Lenders had made

massive amounts of so-called “subprime” mortgage loans to such borrowers, depending entirely

on the expectation of housing-price appreciation—and subsequent refinancing—for

repayment.123 Many of the world’s most sophisticated financial institutions invested billions of

dollars in mortgage-backed securities (“MBS”) that were payable from collections on these

subprime mortgage loans.124 When housing prices failed to appreciate, and in many regions

began to depreciate, these lenders and investors suffered huge losses.125 As a result, subprime

asset-based loans are perceived as inherently risky.126

In reality, though, whether subprime asset-based loans are actually risky depends on the

extent of overcollateralization. Prudent asset-based lending should never have to depend—as

119 The Model Law does not mandate that the loan proceeds must be used to start a small business. Although this Article generally contemplates that use, omitting such a mandate gives borrowers and lenders case-by-case flexibility to negotiate how loan proceeds could be used—implicitly trusting that prudent borrowers will want to use the proceeds to generate wealth and that prudent lenders will condition lending on that prudent use. As appropriate, a lender always has the right to include a use-of-proceeds clause requiring a specific use of the proceeds. 120 See infra note 149.121 See supra notes 117-118 and accompanying text.122 A prudent lender also would want to document that the borrower is economically disadvantaged at the time of making the loan, to ensure that the security interest in the underlying de jure rights is enforceable. Article 4(5) of the Model Law provides a safe harbor for this determination.123 THE FINANCIAL CRISIS INQUIRY COMM’N, THE FINANCIAL CRISIS INQUIRY REPORT: FINAL REPORT OF THE NATIONAL COMMISSION ON THE CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS IN THE UNITED STATES 165 (2011) (hereinafter “FCIC Report”) (stating that many of the subprime mortgage products “would perform only if housing prices continued to rise and the borrowers could refinance at a low rate”).124 See id. at xvi (“When the [housing] bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them.”).125 Id. at 227–228.126 Cf. SINGER, ET AL., supra note 42, at 968–69 (discussing the federal and state laws passed after the financial crisis to regulate subprime mortgage lending (and thus avoid risky lending practices)).

document.docx

25

subprime mortgage lenders depended prior to the financial crisis127—on the expectation of

collateral appreciation for overcollateralization. Instead, prudent subprime asset-based loans

should be adequately overcollateralized at the outset, when they are made.128 In contrast to pre-

crisis subprime mortgage lending, this Article’s vision of extending credit should meet that

prudence standard.

The reason why pre-crisis subprime mortgage lending failed that standard—whereas

extending credit to economically disadvantaged borrowers secured by their de facto rights should

meet it—turns on basic principles of purchase-money lending. A subprime mortgage loan is a

purchase-money loan: a lender advances funds to an economically disadvantaged borrower to

purchase a home and pledge the home as collateral for the loan.129 Because economically

disadvantaged borrowers rarely have money to make a downpayment, the amount of the loan

usually must equal the purchase price of the home.130 The loan therefore is not overcollateralized

when made; it depends on an expectation of home appreciation for overcollateralization.131

In contrast, loans made to economically disadvantaged borrowers secured by their de

facto rights, as contemplated by this Article, are not purchase-money loans. The borrower

already has those de facto rights. A lender would extend credit based on its valuation of the

collateral, with prudent lenders insisting on overcollateralization. To illustrate, say a prospective

borrower resides on property valued by the lender at $100,000 and would like to borrow

$100,000. No prudent lender would make such a loan. A lender might counter, however, with an

127 See supra note 123 and accompanying text.128 Cf. Steven L. Schwarcz, Protecting Financial Markets: Lessons from the Subprime Mortgage Meltdown, 93 MINN L. REV. 373, 390 (2008) (explaining why prudent subprime asset-based lending would require a minimum level of overcollateralization). 129 See e.g., Yuliya Demyanyk & Otto Van Hemert, Understanding the Subprime Mortgage Crisis, 24 R. FIN. STUD. 1848, 1849 (2011); Legal Information Institute, Purchase Money Mortgage, available at https://www.law.cornell.edu/wex/purchase_money_mortgage (last visited Jun. 10, 2018).130 See, e.g., Megan Elliott, Can’t Afford a 20% Down Payment? 6 Ways You Can Buy a Home, MONEY & CAREER CHEATSHEET (Dec. 11, 2017), https://www.cheatsheet.com/money-career/cant-afford-20-percent-down-payment-ways-you-can-buy-a-home.html/?a=viewall.131 See supra note 123 and accompanying text.

document.docx

26

offer to lend $75,000 secured by that collateral—providing significant overcollateralization.132

The prudent lending standard thus will restrict the relative amount an economically

disadvantaged person could borrow against his de facto rights. Nonetheless, that amount may

well be sufficient to start a viable small business.

If needed, this Article’s proposal for borrowing based on de facto collateral rights could

be supplemented to induce lenders to advance higher amounts. For example, some communities

might consider providing cross-guarantees of repayment, which is typical in microfinance

lending.133 Those guarantees would constitute a second source of repayment, and thus would

justify a higher advance rate.134 Governmental or multi-governmental entities might also consider

132 As an industry custom, mortgage lenders often measure overcollateralization by the loan-to-value ratio (“LTV”). See, e.g., CHARLES W. CALOMIRIS & JOSEPH R. MASON, HIGH LOAN-TO-VALUE MORTGAGE LENDING: PROBLEM OR CURE? 25 (1999) (noting that collateral, measured by LTV, is one of the “three Cs” critical to mortgage lending). In the example in the text above, the LTV would be 75% (i.e., $75,000 loan divided by $100,000 collateral value). 133 Disintermediating Avarice, supra note 14, at 1192. Some of the cultural factors that are important for microfinance may also be worth considering. Cf. Kozolchyk, supra note 14, at 737-39 (arguing that credit also depends on having cultural values that recognize a borrower’s duties toward his or her creditors).134 See supra note 115 and accompanying text (discussing two-ways out).

document.docx

27

helping to partially or fully guarantee loans in order to attract private credit,135 or even making

loans directly from public resources.136

E. Would the poor be willing to borrow?

After struggling to empower the economically disadvantaged with credit, this question

may seem anticlimactic. However, people tend to be risk averse.137 A person who lives on land

(or otherwise uses property) may be unwilling to risk losing it in a foreclosure, even if taking that

risk brings the chance to start a successful small business.138 Because half of start-up businesses

fail,139 the risk is significant.

135 Many governmental and multi-governmental organizations have been making these types of guarantees. See, e.g., The World Bank, Guarantees Program, available at http://www.worldbank.org/en/programs/guarantees-program (stating that an important aim of these guarantees program is to “[m]obilize private investment (equity or debt) for strategic projects or sector support”); The World Bank, World Bank Guarantees in Action (Feb. 9, 2018), available at http://www.worldbank.org/en/programs/guarantees-program/brief/world-bank-guarantees-new-project-briefs (detailing “how World Bank guarantees mobilize commercial financing for investment projects, help restructure expensive debt of utilities, and increase developing countries’ access to capital markets”); Export-Import Bank of the United States, Medium and Long-Term Loan Guarantee, available at https://www.exim.gov/what-we-do/loan-guarantee (stating that EXIM Bank provides loan guarantees to help companies “secure competitive financing for [their] international buyers” on competitive terms otherwise unavailable to such buyers). See also Raundi Halvorson-Quevedo & Mariana Mirabile, Guarantees for Development 2 (OECD Mar. 2014) (observing that “Developmental guarantees are a valuable instrument for mobilising private resources—be they from private companies, banks, individuals, NGOs, self-help groups, investment funds, etc. For a fraction of the potential cost of the risk exposure undertaken, considerable liquid resources can be deployed for investments to improve economic and social conditions. . . .”).136 For example, the U.S. government offers several types of direct loans, including small business loans. See GOVERNMENT GRANTS AND LOANS, available at https://www.usa.gov/grants#item-37017. As appropriate, lenders and guarantors might consider negotiating, as a quid pro quo, some profit sharing with borrowers whose businesses ultimately become successful. Cf. supra note 74 (discussing a profit-sharing upside to help balance the risk that holders could lose their underlying de jure rights in a foreclosure). 137 See, e.g., Ruixun Zhang, et al., The Origin of Risk Aversion, 111 PROC. NAT’L ACAD. SCI. U.S. 17777 (2014) (observing that “risk aversion is one of the most fundamental properties of human behavior”). 138 Cf. Trebilcock & Veel, supra note 12, at 407 (observing that even with the ability to collateralize loans, economically disadvantaged parties who are “risk-averse and perceive a risk of losing their land if it is mortgaged” might not borrow).139 See infra note 149 and accompanying text.

document.docx

28

This Article does not purport to reliably predict how many economically disadvantaged

persons would be willing to turn their de facto rights into collateralized credit.140 It merely

observes that people invest their lifesavings into small businesses all the time.141 Moreover, if

necessary to motivate the economically disadvantaged to borrow, governments could consider

subsidizing the resulting businesses or providing back-up housing as a safety net for borrowers

whose businesses fail.142

III. EXPLAINING WHY OVERRIDING PROPERTY LAW TO EMPOWER THE POOR WOULD BE ECONOMICALLY EFFICIENT

This Article has explained from a legal standpoint how and why commercial law should

override property law to enable the economically disadvantaged to use their homes and other

commonly held assets as collateral. Such a legal change, however, would have broad policy

ramifications. When considering a change in law that has significant policy consequences, the

norm is to examine whether the benefits would justify the costs of the change.143 Although

referred to in a regulatory context as a cost-benefit analysis, this is effectively a Kaldor-Hicks

economic efficiency analysis.144

140 Any such prediction would almost certainly require field research in the communities of holders of de facto rights. Even then, there are differences in what people say they will do and what they actually do in untested scenarios. Cf. See, e.g., ENCYCLOPEDIA OF SURVEY RESEARCH METHODS 752 (Paul J. Lavrakas ed., 2008) (observing that response bias can lead to flawed survey results). 141 Cf. Asheesh Advani, Tapping Your Personal Savings to Fund Your Startup, ENTREPRENEUR (Jun. 5, 2006) (observing that “the most popular source of startup financing is the personal savings of the business’s founder”); Martin Zwilling, Top 10 Sources of Funding for Start-ups, FORBES (Feb. 12, 2010) (discussing personal savings as the number one preferred source of funding start-up companies).142 [Expand the above discussion with types of assistance provided by government organizations such as the U.S. Small Business Administration (SBA, https://www.sba.gov/) and similar non-U.S. agencies. cite1]143 See, e.g., ROBIN PAUL MALLOY, LAW IN A MARKET CONTEXT: AN INTRODUCTION TO MARKET CONCEPTS IN LEGAL REASONING 190 (2004).144 Id. See also Steven L. Schwarcz, Changing Law to Address Changing Markets: A Consequence-Based Inquiry, 80 L. & CONTEMP. PROBLEMS 163, 167–168 (2017). Kaldor-Hicks efficiency is the practical standard used by economists to assess the economic desirability of a project.

document.docx

29

A project is Kaldor-Hicks efficient if its overall benefits exceed its overall costs,

regardless of who bears the costs and who gets the benefits.145 Subpart A next estimates the

anticipated benefits, and subpart B then estimates the anticipated costs, of overriding property

law to enable the economically disadvantaged to use their homes and other commonly held

assets as collateral, to obtain credit. Subpart C thereafter balances those benefits and costs.

A. Estimating anticipated benefits

The anticipated benefits of enabling the economically disadvantaged to obtain credit are

incalculable. Assuming the disadvantaged use it to start small businesses, credit not only can

greatly help to alleviate poverty but also can foster economic development—thereby helping to

strengthen both social and financial stability.146 Economic development also has the secondary

benefit of creating additional jobs. In the United States, for example, the Small Business

Administration (SBA) reported that its fiscal year 2016 loans to small businesses “supported

more than 587,000 jobs.”147

B. Estimating anticipated costs

The principal costs of overriding property law to enable the economically disadvantaged

to obtain credit are three-fold: direct harm to owners of the underlying de jure rights, potential

subversion of the rule of law, and the loss of property by economically disadvantaged borrowers

whose ventures fail. Additionally, there are transaction costs. Consider each in turn.

Owners of the underlying de jure rights would be harmed if a lender forecloses on, and

thus obtains ownership of, their rights.148 Foreclosure would occur only if the borrower defaults.

Ideally, borrowers who successfully invest the loan proceeds in small businesses should realize

profits that enable them to repay the loans, avoiding foreclosure. Nonetheless, assuming a worst

145 MALLOY, supra note 143.146 [Expand the above analysis. Does the World Economic Forum or the World Bank, for example, attempt to quantify these types of benefits? See sources cited supra notes 3 & 6. cite1. Also, do economic sources on microfinance attempt to quantify these types of benefits? cite1]147 U.S. Small Business Administration, FY 2018 Congressional Budget Justification and FY 2016 Annual Performance Report, at 28. [What else can be said about benefits or their quantification? cite1]148 Cf. Model Law Arts. 4(2) & 8(2) (giving foreclosing lenders the ability to obtain full rights in the property pledged as collateral).

document.docx

30

case that half of all such businesses fail,149 the owners of the underlying de jure rights to that

collateral would be harmed. Although it is hard to try to quantify that harm, it might reach

hundreds of millions of dollars if not more.150

Owners of the underlying de jure rights might also be harmed if their rights are merely

encumbered by a lender’s security interest. That would limit the owners’ practical ability to

transfer their rights or to use those rights as collateral to raise funding. It is even harder to try to

quantify this harm.

These harms to owners of the underlying de jure rights would be mitigated, however, by

at least two factors. First, this Article proposes to enable such owners to provide clear notice of

their rights, thereby protecting those rights.151 Second, the fact that such owners tolerate or are

unaware of the economically disadvantaged using their property152 indicates that they have little

(at least current) interest in transferring their rights or using those rights as collateral to raise

funding.153

The potential subversion of the rule of law represents a second principal cost. This cost,

however, should be relatively modest. As this Article discusses, commercial law already has set

strong precedents for overriding property law to achieve important policy goals and commercial

realities. Furthermore, the law of adverse possession provides additional precedent for favoring

149 Cf. Patricia Nilsson, London Start-ups are Most Likely to Fail, FIN. TIMES, Oct. 12, 2017, available at https://www.ft.com/content/e3c745c4-88d8-11e7-afd2-74b8ecd34d3b (reporting that “London has the lowest rate of start-up survival in the UK: only 50.1 per cent of companies formed in 2013 endured for three years, 3.6 percentage points below the national average”); David Waring, Small Business Failure Rates: Why All The Stats Have It Wrong (July 26, 2017), available at https://fitsmallbusiness.com/small-business-failure-rates/ (analyzing small business failure rates).150 [Try to make this estimate more rigorous, discussing possible valuation ranges of de facto rights, credit extended, and small business formation. cite1]151 See text accompanying notes 72-76, supra. Cf. Part II.B generally (examining how recognizing de facto rights could be made fair to holders of de jure rights). 152 Cf. supra note 79 and accompanying text (observing that relatively few de jure right-holders likely know of their rights).153 The harms to owners of the underlying de jure rights would be further mitigated if their ownership interests carried over into the businesses started by the de facto owner. See supra note 74.

document.docx

31

de facto rights over de jure rights in circumstances similar to those discussed. Conceptually,

overriding property law to enable the economically disadvantaged to obtain credit would follow

these precedents.

A third principal cost is the loss of property by economically disadvantaged borrowers

whose ventures fail. As discussed, half of start-up businesses fail.154 A borrower who loses her

property in a foreclosure may become homeless. Even if the government provides a safety net,155

the costs involved might run hundreds of millions of dollars more.156

Overriding property law to enable the economically disadvantaged to obtain credit also

entails transaction costs. These include the costs associated with using satellite, drone, or other

overhead imagery to document de facto rights and costs associated with translating that into

descriptions of allocated boundaries.157 Even if these costs add to tens of millions of dollars, they

would be relatively small compared to the two hundreds-of-million-dollars cost estimates

above.158

C. Balancing costs and benefits

The anticipated benefits of enabling the economically disadvantaged to obtain credit are

incalculable, greatly helping to alleviate poverty, thereby strengthening social stability, and also

helping to foster economic development, thereby strengthening financial stability. Although the

costs might be many hundreds of millions of dollars, if not more, the benefits should well exceed

those costs. In that case, this Article’s proposal—to enable the economically disadvantaged to

obtain credit by using their de facto rights as collateral—would be economically efficient.

154 See supra note 149 and accompanying text.155 See supra note 142 and accompanying text.156 [Can this be quantified more rigorously, perhaps by estimating the cost of public [subsistence] housing? cite1]157 See supra note 96 and accompanying text. 158 See text accompanying note 150, supra. [Briefly discuss other possible costs. For communities that provide cross-guarantees of repayment (see supra note 133 and accompanying text), discuss possible default risk. Also, discuss costs associated with governmental or multi-governmental-entity partial or full guarantees (see supra note 135 and accompanying text) or associated with loans made directly from public resources (see supra note 136 and accompanying text).]

document.docx

32

The fact that the benefits and costs accrue to different parties—the benefits to the

economically disadvantaged who hold de facto rights, the costs to the owners of the underlying

de jure rights—is irrelevant to this conclusion. Economic efficiency is satisfied if the overall

benefits exceed the overall costs, regardless of who benefits and who loses.159

IV. IMPLEMENTATION

The analysis has provided a conceptual framework to explain why the economically

disadvantaged should be able to use their de facto rights as collateral to obtain credit. It also

explains how to legally design such a framework. Next consider how such a framework could be

implemented, comparing statutory and judicial approaches.

Being primarily normative, the Article does not purport to comprehensively address

implementation. Nonetheless, several observations may be made. As discussed, changing the law

to enable the economically disadvantaged to use their homes and other commonly held assets as

collateral would have broad policy ramifications.160 Legislatures, which have the capacity to hear

multiple competing constituencies and to fully debate competing ideas, should consider such

fundamental changes.161

Legislatures are additionally well positioned to implement this Article’s framework

because it is technical and deals with a somewhat specialized area of law—secured transactions.

Most ordinary judges are unlikely to have sufficient commercial law background to attempt to

implement the framework. Moreover, judges that address fact-specific cases and controversies

are highly unlikely to have a sufficient mandate in any given case to implement the entire

framework.

159 See supra note 145 and accompanying text.160 See supra note 143 and accompanying text. 161 Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 NOTRE DAME L. REV. 1, 29 (2016) (citing Robert Yalden, Canadian Mergers and Acquisitions at the Crossroads: The Regulation of Defence Strategies After BCE, 55 CAN. BUS. L.J. 389, 410 (2014)).

document.docx

33

These limited observations clearly favor a statutory approach. To facilitate that approach,

the Article proposes a Model Law in Annex 1 that could be considered as a basis for legislative

enactment.162

This Article does not, however, necessarily exclude the option of judicial

implementation. The law of adverse possession, for example, arose from judicial precedents.163 If

legislatures are not prepared to help the economically disadvantaged to use their property as

collateral to obtain credit, judges may wish to contemplate such law reform in appropriate cases

CONCLUSION

Poverty and the shrinking middle class seriously threaten social and financial stability.

Although credit is essential to economic growth and upwards mobility, the poor cannot borrow

because they often hold de facto but not de jure rights in their property. Indeed, seventy percent

of the world’s population does not even have registered title to their land.164

This Article attempts to solve this critical problem. It explains why commercial law

should—and examines how it could—recognize those de facto rights to enable the economically

disadvantaged to obtain collateralized credit. It also proposes the text of a Model Law that could

implement that recognition. This represents a radically different conception of sustainable

finance: one that is no longer dependent on limited charitable sources of funding or on

mandatory regulation of finance to impose social responsibility but, instead, designed to attract

arm’s length funding.

162 In the United States, the American Law Institute and the Uniform Law Commission, which promulgate model commercial law for consideration and enactment by individual state legislatures (see supra notes 18-22 and accompanying text), should also consider the Model Law. 163 See supra notes 65-67 (observing that the roots of adverse possession come from the English common law rule of disseisin).164 See supra note 6 and accompanying text.

document.docx

34

ANNEX 1:MODEL LAW TO RECOGNIZE DE FACTO PROPERTY RIGHTS

Preamble

The shrinking middle class and the widening gap between the wealthy and the economically

disadvantaged create threats to social and financial stability. The lack of credit significantly

increases that wealth gap.

Although credit is essential to economic growth and upwards mobility, many economically

disadvantaged people cannot obtain credit. Because they live in homes built on land that is not

legally recorded as their property or they otherwise hold property in which they have de facto but

not de jure rights, they cannot use that land or other property as collateral.

This Law facilitates the ability of the economically disadvantaged to use certain de facto rights

as collateral, in order to obtain credit.

Chapter I: Scope, Interpretation, and Use of Terms

Article 1: Scope

(1) This Law applies to security interests in both personal property and real property (real

estate).

Article 2: Interpretation

(1) This law shall be liberally construed to reflect commercial realities.

(2) Nothing in this Law shall be interpreted to restrict the protections otherwise available to

borrowers under consumer lending or similar law.

Article 3: Use of Terms

For purposes of this Law, the following terms shall have the following meanings:

document.docx

35

(1) “borrower” means an economically disadvantaged person who borrows money or

otherwise obtains credit under this Law;

(2) “clear notice” means notice that is physically obvious and manifestly clear, including

without limitation posting no-trespassing signs, locking doors, and/or blocking entry or access to

property;

(3) “collateral” means property that is subject to a security interest;

(4) “de facto rights” means rights—including those recognized or respected in practice—

associated with using property or excluding the use of property by others, to the extent such

rights are not formally recognized or respected under official law;

(5) “economically disadvantaged” means lacking sufficient money or other resources to live

at a standard considered [comfortable or normal in a society];

(6) “security agreement” means a contract granting a security interest under this Law.

(7) “security interest” means a charge against or an interest in property to secure payment of

a debt or performance of an obligation;

(8) “underlying de jure rights” means rights that are formally recognized or respected under

official law, to property in which a third party has de facto rights.

Chapter II: Creation of Security Interest

Article 4: Creating the Security Interest

(1) Economically disadvantaged persons shall have the right to grant a security interest in

their de facto rights as collateral, in order to obtain credit. Such right ordinarily shall be

evidenced by a security agreement.

(2) Except as provided in subpart (3) below, the grant of such a security interest shall be

deemed also to include a security interest in the underlying de jure rights.

(3) The grant of a security interest in de facto rights under this Law shall not include a

security interest in the underlying de jure rights if (i) at any time within the 90-day period prior

to the grant of a security interest in such de facto rights, there exists clear notice of the intent of

the owner of the underlying de jure rights to preserve such de jure rights and (ii) the owner of

such underlying de jure rights is not a governmental entity.

document.docx

36

(4) Except as otherwise specifically permitted in Article 4(3), notice thereunder shall not

impair the de facto rights of any economically disadvantaged person.

(5) Any reasonable determination made by a lender in good faith and contemporaneous with

the grant of a security interest that the borrower is economically disadvantaged shall be

conclusive evidence thereof.

Article 5: Describing the Collateral

(1) The collateral shall be described in the security agreement.

(2) Such description of collateral shall allocate the relevant de facto rights within the

underlying de jure rights using any reasonable method.

(3) The following shall be deemed to constitute a reasonable method of allocation. Either the

government, a non-governmental organization, or a local neighborhood association organizes

persons residing on the underlying de jure rights to allocate their de facto property rights by

setting flags or other visible markers at the boundaries, which satellite or other overhead imagery

would then document for translation into a description of those allocated boundaries.

(4) The allocation shall be transcribed to a searchable government record, located at [name of

governmental record office].

(5) Lenders may conclusively rely on the validity and enforceability of collateral descriptions

that comply with this Article 5.

Chapter III: Perfection of Security Interest

Article 6: Creating Perfection

(1) A description of collateral filed with [name of governmental mortgage-recording office]

shall constitute perfection of the security interest created under this Law.

Article 7: Describing the Collateral

(1) Such description shall be deemed to be sufficient if it provides notice that the collateral

may be subject to a security interest under this Law.

(2) A standard description of the underlying de jure rights in which the security interest is

allocated shall be deemed to constitute a sufficient description. This description could copy the

document.docx

37

existing recorded description of the underlying de jure rights; it need not describe the allocated

rights per se.

Chapter IV: Foreclosure on Security Interest

Article 8: Foreclosure

(1) Upon default by the borrower under a security agreement, the lender shall have the right

to exercise remedies against the collateral to the extent provided after default under otherwise

applicable secured transactions law.

(2) To the extent the grant of a security interest is deemed, under Article 4 of this Law, also

to include a security interest in the underlying de jure rights, the lender’s remedies under Article

8(1) shall extend to those underlying de jure rights.165

Chapter V: Government Assistance166

Article 9: Government Guarantees

(1) At its option, [name of government agency] may guarantee repayment of all or a portion

of any loans made under this Law.

(2) Such a guarantee may be made on whatever terms and conditions [name of government

agency] deems appropriate from time to time.167

Article 10: Government Loans

(1) At its option, [name of government agency] may make direct loans under this Law.

(2) Such a loan may be made on whatever terms and conditions [name of government

agency] deems appropriate from time to time.168

165 [The Model Law could also give holders of the underlying de jure rights a profit-sharing upside in the business started by the borrower, to help to balance the risk that holders could lose their rights in a foreclosure. See note 74, supra.]166 [Chapter V is an optional part of the Law.]167 [These terms and conditions might include profit sharing. See note 136, supra.]168 [Again, these terms and conditions might include profit sharing. See id.]

document.docx